Wednesday, April 11, 2012

Cumberland Advisors: I'm Worried

A profound read by David Kotok, Chairman & Chief Investment Officer of Cumberland Advisors, on reasons the U.S. and other G-4 developed nations have long term reason to be worried.

http://www.cumber.com/commentary.aspx?file=040812.asp

A few key excerpts:

When I get worried, I read and re-read in my library....A favorite of mine is Paul Kennedy.  Twenty-five years ago, this Yale historian concluded his monumental work The Rise and Fall of Great Powers with a profound observation:
"In the largest sense of all, therefore, the only answer to the question increasingly debated by the public of whether the United States can preserve its existing position is ‘no – for it simply has not been given to any one society to remain permanently ahead of all the others, because that would imply a freezing of the differential pattern of growth rates, technological advance, and military developments which has existed since time immemorial."
Kennedy then argued that the United States has the ability to moderate or accelerate the pace of decline.  Such is also the case for other great powers, many of which are in a state of decline from their centuries-old power peak. Among others in his treatise, Kennedy's history lessons examine Spain, France, Rome, and the Austro-Hungarian Empire.
I think I just covered a lot of the euro-zone geography.  
In 1987, Kennedy warned us, "The task facing American statesmen over the decades, therefore, is to recognize that broad trends are under way, and that there is a need to ‘manage’ affairs so that the relative erosion of the United States' position takes place slowly and smoothly."  He added the additional warning that it not be "accelerated by policies which bring merely short-term advantage but longer-term disadvantage."
Unfortunately, America's leadership has not heeded such warnings.
Rising deficit financing has been facilitated by falling nominal interest rates.  That combination leads to level, or even falling, aggregate debt service.  You can owe more and more and have smaller and smaller monthly payments.  That is the magic of falling interest rates.  Until they hit the zero boundary.
Is this a healthy situation?  How long can it persist?  What happens next?  When interest rates eventually rise, what will be the result of this blend of monetary/fiscal policy as its unwinding turns malignant?
Moreover, who then will be the politicians that inherit this mess?  Who will occupy the central banker's chair?
I worry because there is no rationally explained strategic-exit plan in the G4. Not in the US.  Not in Japan.  Not in the euro zone.  Not in the United Kingdom.
Zero-bound interest rates are a short-term advantage.  We enjoy them. We profit from them.  We expect them to continue for a while.  They are like the oxygen administered to a very ill patient.  If the patient dies, the oxygen has eased the pain in the terminal phase.  If the patient lives, the lungs have been scarred and need many years of healing and repair.  Today, the patient is receiving oxygen in the G4.  Death is being delayed (Greece) or, perhaps, thwarted (elsewhere in the euro zone, Japan, US, and UK).

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